The good old days are long gone when you could easily get a bank loan to buy a business. Lending practices are constantly changing, and sometimes banks cannot accommodate unique business situations. Creative financing is the norm for today’s business buyers.
Fortunately, there are a number of options you can consider. Your business broker can help you write these into your letter of intent or offer to purchase. An ideal financing situation is to have a seller take a down payment and carry a note for the balance. Because there is no delay in waiting for bank approval, the closing can occur soon after the seller and buyer agree on price and terms. A seller will usually require a larger down payment than a bank; and some sellers completely refuse to carry the note, even with a large down payment. Even though they would get the business back if the buyer defaults in payment, they are afraid the buyer might run the business down, causing them to have to take it back and rebuild it. Safeguards can be placed on the loan, such as requiring frequent financial statements to be sent to the seller and the seller’s ability to walk in for a physical inspection at any time. An advantage to the seller is taxes are only owed on the amount the buyer pays to the seller each year, rather than the entire amount the year of closing.
Another form of seller financing is earnout financing, which involves a certain dollar amount agreed on by the buyer and seller based on the performance after the transaction has been completed. Earnout financing is often used for companies that are in a turn around situation or when buyers are purchasing on potential, rather than on historical cash flow.
As conventional loans usually are not available for the sale of a business, buyers usually go to a Small Business Administration (SBA) lender. That is a bank that does SBA loans. It is important to go to a Preferred Lender, which means the bank makes the credit decision, making it possible to obtain quick preliminary approval after receipt of a completed application. Although it is more difficult, as banks like to have something solid they can put their hands on for collateral, a loan against goodwill under a business acquisition scenario can be granted. Real estate is not required as long as the cash flow and other credit issues are solid. The bank actually makes the loan, and SBA guarantees it, usually up to 75% or 80%. They will usually require the seller to carry a small note, depending on several factors, which makes the bank more comfortable with the transaction. Lenders know they have a seller who has a vested interest in the success of the business rather than one who will take their money and run.
It is important to have a well written business plan to give to the lender along with your application for funding. Included will be accurate financial statements for the current year and projected (Pro Forma) financial statements for the first three years of your loan. The lender will need this to determine if the business can realistically afford the loan, making the loan payments, keeping the business running, and providing income for you.
Talk with a business broker representing the business you are considering purchasing to help you determine if the owner is willing to consider seller financing, earnouts, or other creative financing ideas. Based on your available capital, the business broker should be able to tell you whether you will be considered for the purchase and may also provide references to various preferred lenders who are familiar with financing the purchase of a business. We have all been affected by the slow economy the past few years, but our new government administration gives us hope again for a prosperous growing economy. Don’t wait to buy a business. Consider creative financing!
